Economist: Uneven recession could cause long-term economic decline

Construction site in Estonia.
Construction site in Estonia. Source: ERR

According to Bank of Estonia (Eesti Pank) economist Kaspar Oja, the current recession is characterized by unequal distribution, which could contribute to a protracted period of stagnation. According to Mihkel Nestor, an analyst at SEB, the poor state of Estonian exports is due to the consequences of the pandemic and the recognition of Nordic real estate difficulties.

While regional economic inequality is considered bad, Statistics Estonia says that Estonia is now at risk of an uneven distribution of the recession. According to the agency, short-term business indicators, GDP for the most recent quarter and other recent surveys are increasingly indicative of a recession.

According to Kaspar Oja, an economist at Eesti Pank, the uneven growth represents the normalization of the situation, but there are also signs of concern. The current unequal growth, in particular, could lead to an excessive weakening of the economy's exporting branches and a strengthening of the domestic services sector.

"If the competitiveness of the export sector declines, Estonia's future economic growth may be weaker, because as a small country we are heavily dependent on the export sector," he explained. "Something similar has happened in the past, for example in Finland after the international financial crisis. Domestically driven growth helped Finland to weather the crisis more easily, but the competitiveness of the exporting sector declined and this led to a prolonged low-growth slump."

However, Oja said that the downturn is relatively broad-based at the moment, as the declining sectors in Estonia accounted for 67 percent of value added in the first quarter, so it cannot be said that only a small part of the economy is in decline.

The fact that demand for industrial production is low practically everywhere, according to SEB's economic analyst Mihkel Nestor, is the fundamental reason why the current crisis is impacting the exporting industry hardest.

"This is partially a consequence of the pandemic: because many services were unavailable at the time, people spent money on items. Today, however, people's desires are inverted, resulting in fewer jobs in the industry," he said.

In addition, a specific risk has materialized for the Estonian exporting industry in relation to the Nordic real estate and construction markets: a significant portion of Estonian exports have consisted of sales of furniture, building materials, prefabricated houses, and the like to Sweden, Finland and Norway, where the real estate market is in a lull and demand is extremely low.

"Residential development in Sweden is predicted to fall by nearly half compared to last year. Unfortunately, it will take time for building activity to return, therefore we do not expect any fast improvements in the Estonian economy," Nestor said.

Oja went on to say that the sectors of the economy most reliant on raw materials from Russia and Belarus have suffered the most; when timber shipments ended in July of last year, the timber industry's output plummeted dramatically. Companies in the information technology sector have also indicated that the change in access to funding is impacting their expansion plans and consumer demand.

The economy is characterized by three major trends

Oja said that the economy is presently characterized by three main trends: the recovery from the pandemic crisis, the settling in of the effects of the war, and the global slowdown caused by rising interest rates.

"Overall, these trends have led to the strengthening of the services sector and the weakening of other sectors," he said.

The recovery from the pandemic crisis continues to influence consumption patterns: there has been an increase in international travel, but this may be countered by a fall in retail expenditure.

"Retail sales increased significantly in the aftermath of the pandemic crisis. In the first quarter, we noticed that the tourism-oriented sectors of the economy performed slightly better than average," the Eesti Pank economist added.

Despite the fact that Estonia's domestic economy has fared better than its exports, Nestor said that there have been significant changes in this sector as well; whereas sales in the retail sector used to decline only in terms of volume, they have now begun to decline in terms of revenue as well.

"This is primarily due to a lack of consumer confidence, as well as an earlier in the year very strong consumption boom that was unable to continue," the economist said.

According to him, the service sector, such as hotels-restaurants, travel, etc., which is in high demand not only in Estonia but worldwide, has fared the best. Nestor anticipates that consumer demand in Estonia will not suffer severe setbacks as long as the labor market condition remains relatively good.

"First and foremost, the success of various economic sectors can influence the structure of the economy and the labor market, with services employment expanding at the expense of industry employment. However, given manufacturing's chronic productivity challenges, this may not be a terrible thing for the economy as a whole," Nestor said.


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Editor: Kristina Kersa

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